Commentary on the economic , geopolitical and simply fascinating things going on. Served occasionally with a side of snark.

Thursday, December 5, 2013

Too Big To Fail Bankster Watch -- December 5 , 2013 - Volcker Rule To Scrap "Portfolio Hedging", Would Make Trillions In Excess Deposits Inert ..... Even as Portfolio hedging seems as if it might be neutered , TBTF Banks more dominant than ever in the US as US Banks fall to record low numbers...... “Implicit” Government Guarantees To Bail Out Bank Creditors Tighten Their Grip On US Taxpayers

Volcker Rule To Scrap "Portfolio Hedging", Would Make Trillions In Excess Deposits Inert

As we have been covering for the past year and a half, most explicitly in "A Record $2 Trillion In Deposits Over Loans - The Fed's Indirect Market Propping Pathway Exposed", when it comes to the pathway of the Fed's excess deposits propping up risk levels, it has nothing to do with reserves sitting on bank balance sheets as assets, and everything to do with excess deposits (of which there are now $2.4 trillion thanks to the Fed) which are used as Initial collateral by banks such as JPM and then funding such derivatives as IG9 in a failed attempt to cover a segment of the corporate bond market. These deposits originate at the Fed as a liability at the commercial banking sector to the excess reserve asset.

That much is clear and undisputed, and was admitted by none other than JPM itself.

Of course, before it was penalized hundreds of millions for Jamie Dimon's tempest in a teapot comments, and implicitly lying before Congress, the party line is that when JPM's CIO unit proceeded to use the $423 billion (at the time) deposit to loan gap as funds to sell IG9 protection, it was "hedging."

It wasn't, and instead it was merely putting on one of the largest prop trades in history which can be confirmed by the great bonus expectations of Bruno Iksli and pals. And since nobody expects to make an extra bonus on a hedge to an existing trade, but always on a new directional trade, one can ignore the lies that any such massive prop trade are covered up with.

Which is why the news overnight from the WSJ that the Volcker Rule (if and when it is implemented) will do away with such "portfolio hedging" trades may have major consequences.

In a defeat for Wall Street, the "Volcker rule" won't allow banks to enter trades designed to protect against losses held in a broad portfolio of assets, according to people familiar with the rule. The practice, known as portfolio hedging, has become a focal point of regulators drafting the rule, a controversial plank of the 2010 Dodd-Frank financial law that seeks to prevent banks from putting their own capital at risk in pursuit of trading profits.

But it won't contain language permitting portfolio hedging, which has been "expunged" from earlier drafts of the rule, according to a person familiar with the matter. Regulators decided to remove portfolio hedging from the rule after J.P. Morgan Chase disclosed billions of dollars in losses from its so-called London whale trades in 2012.

The bank initially described the trades as a portfolio hedge. Now, it is likely other Wall Street firms also will end up paying for J.P. Morgan's slip-up. Regulators, in response to the J.P. Morgan disclosure, pushed to write a rule that would ensure banks couldn't engage in such trades.

The move will come as a blow to banks, which lobbied regulators to keep language allowing portfolio hedging in the rule. Banks often hedge to offset the risks that accompany trading with clients. Sometimes, though, there is no perfect counterweight to those clients' trades. Banks look to portfolio hedging to manage a broader array of risks.

What hedges don't do, regulators wrote, is "give rise…to any significant new or additional risk that is not itself hedged contemporaneously." The excerpt reviewed by the Journal didn't mention portfolio hedging.

For once regulators and politicians not only understood the underlying issues but did the right thing:

Critics said that opened the door for banks to make all manner of bets on the market because a bank might define the risk to its portfolio broadly, such as the risk of a U.S. recession.

And while we are confident the banks will find a way to delay the implementation or outright bring the "hedging" permissive language back, this change - unless remedied - has the potential to make a huge dent on bank P&Ls as it would mean the end of using the Fed's excess reserves to buy up risk and to push the market higher through such instruments as buying ES, selling index protection and other marginable futures and derivatives.

In effect, should the "portfolio hedging" language be kept off the books, it would mean the permanent clogging of a pathway that allowed the Fed's trillions in excess deposits to be used to push stocks higher.

We hardly need to explain the dramatic implications for stocks such a shift would create.

One of the few rebellious Fed heads, Richmond Fed President Jeffrey Lacker, fired another salvo when he was testifying at the House Judiciary Committee’s hearing. And he hit Wall Street risks that are wrapping their growing tentacles ever more tightly around the economy and taxpayers.

The hearing, according to Chairman Bob Goodlatte, would examine whether the Bankruptcy Code is “best equipped” to deal with the insolvency of large banks, such as the “unusual level of speed” needed for their “efficient and orderly resolution,” and the “unique threats” their collapse would pose to the “broader stability of the economy.”

Lacker was on his turf. For years, he has spoken out against QE. Earlier this year, he committed heresy by admitting that “labor market conditions are affected by a wide variety of factors outside a central bank’s control“; he’d yanked away the Fed’s fig leaf for its QE and zero-interest-rate policies. And in June 2012, before QE3 had appeared on the horizon, he’dstunned his listeners when he said, “Monetary policy doesn’t have a lot of capability right now for enhancing growth.” He dissented at the FOMC meetings in 2012 when he last was a voting member. His concerns were confirmed by QE3’s subsequent failure to budge the economy, though it inflated glorious assets bubbles all around.

Now, in his prepared remarks, he told the Committee that the Bankruptcy Code should be tweaked to make it “feasible to resolve failing financial firms in bankruptcy.” The financial crises showed “glaring deficiencies” in the way “distress and insolvency” of big banks are handled, he said. Meaning, they were all bailed out by the Fed and to a much smaller extent by TARP, when there should have been a system in place to wind the failing ones down in bankruptcy. The bailout of investors has created, he said, “two mutually reinforcing expectations”:

First, many financial institution creditors feel protected by an implicit government commitment of support should the institution face financial distress. This belief dampens creditors’ attention to risk and makes debt financing artificially cheap for borrowing firms, leading to excessive leverage.

This belief also encourages the riskiest types of borrowing, “such as short-term wholesale funding,” that could evaporate at a moment’s notice and leave banks and other companies high and dry, which is what had happened during the financial crisis. And these types of funding then “prompt the need” for an implicit government or Fed “protection,” he said.

Second, policymakers may well worry that if a large financial firm with a high reliance on short-term funding were to file for bankruptcy under the U.S. bankruptcy code, it would result in undesirable effects on counterparties, financial markets, and economic activity. This expectation induces policymakers to intervene in ways that allow short-term creditors to escape losses, such as through central bank lending or public sector capital injections. This reinforces creditors’ expectations of support and firms’ incentives to grow large and rely on short-term funding, resulting in more financial fragility and more rescues.

He cited the Richmond Fed’s research into how expectations of creditor bailouts – the implicit guarantees – have grown over time.

In its 2013 estimate, using 2011 data, the Richmond Fed found that there were $44.5 trillion in total liabilities in the financial system, such as bank deposits and bonds. Of them, $10.6 trillion (23.8%) carried explicit guarantees, such as FDIC deposit insurance. And a stunning $14.83 trillion (33.4%) carried implicit guarantees. Unlike FDIC insurance, these guarantees are issued for free to the beneficiary, and when they come due during a bailout, all Americans are forced to pay, through either government or Fed action, to protect the wealth of the creditors. These implicit guarantees in 2011 amounted to 97% of GDP!

They have done nothing but balloon. The Richmond Fed’s first estimate, using 1999 data, found that implicit guarantees amounted to $3.4 trillion (18% of the liabilities in the financial system). A mere 27.6% of GDP. Another screaming data point – as if we needed anymore – in how Wall Street’s risks have been wrapping their ever larger tentacles around the US economy and the taxpayer.

How could this happen? How could these expectations of creditor bailouts balloon so fast so much? Who encouraged it? Well, the Fed and the government. “Through gradual accretion of precedents,” Lacker explained. One bailout followed by a bigger one, followed by an even bigger one, etc., followed by the massive bailouts during the financial crisis. It has been going on for four decades, he said.

While these implicit guarantees have altered risk-taking on Wall Street, banks have become fewer and bigger. In the mid-1980s, there were over 18,000 federally insured banks. Now there are 6,891. Of the goners, 17% collapsed; the rest were mergers and consolidations, based on FDIC data cited by the Wall Street Journal.

Of the survivors, 98.6% are banks with $10 billion or less in assets that control 12% of all assets in the banking industry. Then there are 70 regional banks with up to $250 billion in assets. They make up 1.2% of all banks but control 19% of all bank assets. Should any of them fail, it would entail private-sector losses and ownership changes with minimal governmental intervention. And then there are 12 megabanks – 0.17% of all banks that control 69% of the banking assets!

Their “owners, managers, and customers believe themselves to be exempt from the processes of bankruptcy and creative destruction,” Dallas Fed President Richard Fisher pointed out when he once againvituperated against TBTF banks that, as “everyone and their sister knows,” were “at the epicenter” of the financial crisis. They “capture the financial upside” of their bets but are bailed out when things go wrong, “in violation of one of the basic tenets of market capitalism.”

While Chairman Bob Goodlatte bent over backwards to address ostensibly the collapse “of large and small financial institutions,” everyone knew he was talking about just 12 banks, the only banks in the country exempt from the Bankruptcy Code. Their bondholders are benefiting, free of charge, from implicit guarantees in the size of America’s GDP. These guarantees have encouraged banks, aided and abetted by the Fed, to pile on mountains of risk as if the financial crisis had never happened.

Bu it has done nothing for the real economy, a rather drab place, where consumers try to make ends meet as they entered the holiday shopping season with shootings, stabbings, tramplings, fights, pepper sprayings.... “Only in America people trample each other for sales exactly one day after being thankful for what they already have,” a tweet explained. But it’s been tough for retailers too. Read.... Strung-out Consumers, Desperate Retailers, Crummy Sales

The too big to fail banks have a larger share of the U.S. banking industry than they have ever had before. So if having banks that were too big to fail was a "problem" back in 2008, what is it today?

As you will read about below, the total number of banks in the United States has fallen to a brand new all-time record low and that means that the health of the too big to fail banks is now more critical to our economy than ever. In 1985, there were more than 18,000 banks in the United States. Today, there are only 6,891 left, and that number continues to drop every single year. That means that more than 10,000 U.S. banks have gone out of existence since 1985.

Meanwhile, the too big to fail banks just keep on getting even bigger. In fact, the six largest banks in the United States (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) have collectively gotten 37 percent larger over the past five years. If even one of those banks collapses, it would be absolutely crippling to the U.S. economy. If several of them were to collapse at the same time, it could potentially plunge us into an economic depression unlike anything that this nation has ever seen before.

Incredibly, there were actually more banks in existence back during the days of the Great Depression than there is today. According tothe Wall Street Journal, the federal government has been keeping track of the number of banks since 1934 and this year is the very first time that the number has fallen below 7,000...

The number of federally insured institutions nationwide shrank to 6,891 in the third quarter after this summer falling below 7,000 for the first time since federal regulators began keeping track in 1934, according to the Federal Deposit Insurance Corp.

And the number of active bank branches all across America is falling too. In fact, according to the FDIC the total number of bank branches in the United States fell by 3.2 percent between the end of 2009 and June 30th of this year.

Unfortunately, the closing of bank branches appears to be accelerating. The number of bank branches in the U.S. declined by 390during the third quarter of 2013 alone, and it is being projected that the number of bank branches in the U.S. could fall by as much as 40 percent over the next decade.

Can you guess where most of the bank branches are being closed?

If you guessed "poor neighborhoods" you would be correct.

According to Bloomberg, an astounding 93 percent of all bank branch closings since late 2008 have been in neighborhoods where incomes are below the national median household income...

Banks have shut 1,826 branches since late 2008, and 93 percent of closings were in postal codes where the household income is below the national median, according to census and federal banking data compiled by Bloomberg.

It turns out that opening up checking accounts and running ATM machines for poor people just isn't that profitable. The executives at these big banks are very open about the fact that they "love affluent customers", and there is never a shortage of bank branches in wealthy neighborhoods. But in many poor neighborhoods it is a very different story...

About 10 million U.S. households lack bank accounts, according to a study released in September by the Federal Deposit Insurance Corp. An additional 24 million are “underbanked,” using check-cashing services and other storefront businesses for financial transactions. The Bronx in New York City is the nation’s second most underbanked large county—behind Hidalgo County in Texas—with 48 percent of households either not having an account or relying on alternative financial providers, according to a report by the Corporation for Enterprise Development, an advocacy organization for lower-?income Americans.

And if you are waiting for a whole bunch of new banks to start up to serve these poor neighborhoods, you can just forget about it. Because of a whole host of new rules and regulations that have been put on the backs of small banks over the past several years, it has become nearly impossible to start up a new bank in the United States. In fact, only one new bank has been started in the United States in the last three years.

So the number of banks is going to continue to decline. 1,400 smaller banks have quietly disappeared from the U.S. banking industry over the past five years alone. We are witnessing a consolidation of the banking industry in America that is absolutely unprecedented.

Just consider the following statistics. These numbers come from a recent CNN article...

-The assets of the six largest banks in the United States have grown by 37 percent over the past five years.

-The U.S. banking system has 14.4 trillion dollars in total assets. The six largest banks now account for 67 percent of those assets and all of the other banks account for only 33 percent of those assets.

-The five largest banks account for 42 percentof all loans in the United States.

-Bank of America accounts for about a third of all business loans all by itself.

-Wells Fargo accounts for about one quarter of all mortgage loans all by itself.

-About 12 percent of all cash in the United States is held in the vaults of JPMorgan Chase.

As you can see, without those banks we do not have a financial system.

Our entire economy is based on debt, and if those banks were to disappear the flow of credit would dry up almost completely. Without those banks, we would rapidly enter an economic depression unlike anything that the United States has seen before.

It is kind of like a patient that has such an advanced case of cancer that if you try to kill the cancer you will inevitably also kill the patient. That is essentially what our relationship with these big banks is like at this point.

Unfortunately, since the last financial crisis the too big to fail banks have become even more reckless. Right now, four of the too big to fail banks each have total exposure to derivatives that is well in excess of 40 TRILLION dollars.

Keep in mind that U.S. GDP for the entire year of 2012 was just 15.7 trillion dollars and the U.S. national debt is just 17 trillion dollars.

So when you are talking about four banks that each have more than 40 trillion dollars of exposure to derivatives you are talking about an amount of money that is almost incomprehensible.

Posted below are the figures for the four banks that I am talking about. I have written about this in the past, but in this article I have included the very latest updated numbers from the U.S. government. I think that you will agree that these numbers are absolutely staggering…

JPMorgan Chase

Total Assets: $1,947,794,000,000 (nearly 1.95 trillion dollars)

Total Exposure To Derivatives: $71,289,673,000,000 (more than 71 trillion dollars)

Citibank

Total Assets: $1,319,359,000,000 (a bit more than 1.3 trillion dollars)

Total Exposure To Derivatives: $60,398,289,000,000 (more than 60 trillion dollars)

Bank Of America

Total Assets: $1,429,737,000,000 (a bit more than 1.4 trillion dollars)

Total Exposure To Derivatives: $42,670,269,000,000 (more than 42 trillion dollars)

Goldman Sachs

Total Assets: $113,064,000,000 (just a shade over 113 billion dollars – yes, you read that correctly)

Total Exposure To Derivatives: $43,135,021,000,000 (more than 43 trillion dollars)

Please don't just gloss over those huge numbers.

Let them sink in for a moment.

Goldman Sachs has total assets worth approximately 113 billion dollars (billion with a little "b"), but they have more than 43 TRILLON dollars of total exposure to derivatives.

That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 381 times greater than their total assets.

Most Americans do not understand that Wall Street has been transformed into the largest casino in the history of the world. The big banks are being incredibly reckless with our money, and if they fail it will bring down the entire economy.

The biggest chunk of these derivatives contracts that Wall Street banks are gambling on is made up of interest rate derivatives. According to the Bank for International Settlements, the global financial system has a total of 441 TRILLION dollars worth of exposure to interest rate derivatives.

When that Ponzi scheme finally comes crumbling down, there won't be enough money on the entire planet to fix it.

We had our warning back in 2008.

The too big to fail banks were in the headlines every single day and our politicians promised to fix the problem.

But instead of fixing it, the too big to fail banks are now 37 percent larger and our economy is more dependent on them than ever before.

And in their endless greed for even larger paychecks, they have become insanely reckless with all of our money.

Mark my words - there is going to be a derivatives crisis.

When it happens, we are going to see some of these too big to fail banks actually fail.

At that point, there will be absolutely no hope for the U.S. economy.

We willingly allowed the too big to fail banks to become the core of our economic system, and now we are all going to pay the price.